Deciding whether to invest or be a hard money lender

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Deciding whether to invest or be a hard money lender

Adam Peacock
Rental Property Investor · Member since 2019 · 48 posts · 38 votes

So as I was reading the forums where hard money lenders were being researched, a thought struck me. I am a high earner and have maybe $150k extra cash per year to invest. If I were to use that cash to invest in buying homes, that carries one set of challenges and a correlating set of probable profit expectations. But if I were to start lending my money to others at say 12%, that seems it would be far easier and a higher return.

Can someone check my math and tell me if I've calculated this correctly?

Pasted from Excel

$ 50K Per loan average
3 Est funds per year
12% Rate
Year Principal Balance + Profit
1 $ 168,000.00  
2 $ 336,000.00 (reinvesting principal + interest from prior year)  
3 $ 672,000.00  
4 $ 1,008,000.00  
5 $ 1,344,000.00  
6 $ 1,680,000.00  
7 $ 2,016,000.00  
8 $ 2,352,000.00  
9 $ 2,688,000.00  
10 $ 3,024,000.00  

If my math above is in fact correct, are there resources to learn more about operating as a hard money lender? Are there methods that would result in a higher return than that shown above?

//adam

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Ryan BlakePro Member
Lender · TX · Member since 2018 · 936 posts · 713 votes
7y

@Adam Peacock

You have some small flaws in the math. The largest being is you are expecting a 100% rate of having your money in use. Just like a rental owner needs to account for vacancy, a hard money lender needs to account for down time in their investment.

You are not including some basic expenses the biggest one being marketing.

As an active HML, I can tell you that the average size of our 548 loans we wrote last year were $135k. This means you would only be able to draft about one loan at a time and would have some excess cash that may never be used for the entire year. This also means that you will be turning a lot of people away. If you can only write one loan the first year, 2 the second and maybe 4 the 3rd year, you will be turning a lot of people down and they will be instead building relationships with other more stable HMLs. Again, the group I work with is considered somewhat small and we have access to $120 million that we lend out.

Final thing I think that is getting missed is your foreclosure/non-preforming rate. Depending on which state you are in it can take 2 months up to 2 years to foreclose all the while you as the mortgagee will be responsible for the back taxes when you take the property over. We very very rarely turn a profit when we have to foreclose on a property.

Suggestions: Offer a lower rate than HMLs in your area, like 10%. Charge 1 point or less (you hadn't calculated points), and make sure the closing fees you use will cover your legal expenses for each loan. Based on returns that I see I would suggest using somewhere around 8 - 9.5% as an expected annual return given the interest and point I suggested.

Hope this helped shed a bit of light on things.

[email protected]214-420-7324
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  • Adam Peacock
    OP
    Rental Property Investor · Member since 2019 · 48 posts · 38 votes
    7y

    Revised table to check math:

    $ 50,000.00 per loan
    3 funds per year      
    0.12 Rate % (decimal)      
             
    Year Total Contrib Principal Principal + Profit Gross Profit (Contrib) Gross Profit (Total) Total Basis
    1 $ 150,000 $ 150,000 $ 18,000 $ 18,000 $ 168,000
    2 $ 300,000 $ 318,000 $ 36,000 $ 38,160 $ 356,160
    3 $ 450,000 $ 506,160 $ 54,000 $ 60,739 $ 566,899
    4 $ 600,000 $ 716,899 $ 72,000 $ 86,028 $ 802,927
    5 $ 750,000 $ 952,927 $ 90,000 $ 114,351 $ 1,067,278
    6 $ 900,000 $ 1,217,278 $ 108,000 $ 146,073 $ 1,363,352
    7 $ 1,050,000 $ 1,513,352 $ 126,000 $ 181,602 $ 1,694,954
    8 $ 1,200,000 $ 1,844,954 $ 144,000 $ 221,394 $ 2,066,348
    9 $ 1,350,000 $ 2,216,348 $ 162,000 $ 265,962 $ 2,482,310
    10 $ 1,500,000 $ 2,632,310 $ 180,000 $ 315,877 $ 2,948,187
    0Reply
  • Account Closed
    Specialist · Paradise Valley, AZ · Member since 2018 · 3k+ posts · 2k+ votes
    7y
    Originally posted by @Adam Peacock:

    So as I was reading the forums where hard money lenders were being researched, a thought struck me. I am a high earner and have maybe $150k extra cash per year to invest. If I were to use that cash to invest in buying homes, that carries one set of challenges and a correlating set of probable profit expectations. But if I were to start lending my money to others at say 12%, that seems it would be far easier and a higher return.

    Can someone check my math and tell me if I've calculated this correctly?

    Pasted from Excel

    $ 50K Per loan average
    3 Est funds per year
    12% Rate
    Year Principal Balance + Profit
    1 $ 168,000.00  
    2 $ 336,000.00 (reinvesting principal + interest from prior year)  
    3 $ 672,000.00  
    4 $ 1,008,000.00  
    5 $ 1,344,000.00  
    6 $ 1,680,000.00  
    7 $ 2,016,000.00  
    8 $ 2,352,000.00  
    9 $ 2,688,000.00  
    10 $ 3,024,000.00  

    If my math above is in fact correct, are there resources to learn more about operating as a hard money lender? Are there methods that would result in a higher return than that shown above?

    //adam

     Your math may or may not be correct but there are tax advantages to holding properties that you have to consider. Also, since you have a day job and want passive income you should look at the technique I employ and teach and that is buying properties using creative financing and selling to tenant buyers. The numbers look something like the following spreadsheet. It isn't about how much you make, it's about how much you keep.

    Average Cash Flow Per Door In Phoenix Metro Area

    https://www.biggerpockets.com/forums/600/topics/584916-average-cash-flow-per-door-in-phoenix-metro-area

    2Reply
  • Ryan BlakePro Member
    Lender · TX · Member since 2018 · 936 posts · 713 votes
    7y

    @Adam Peacock

    You have some small flaws in the math. The largest being is you are expecting a 100% rate of having your money in use. Just like a rental owner needs to account for vacancy, a hard money lender needs to account for down time in their investment.

    You are not including some basic expenses the biggest one being marketing.

    As an active HML, I can tell you that the average size of our 548 loans we wrote last year were $135k. This means you would only be able to draft about one loan at a time and would have some excess cash that may never be used for the entire year. This also means that you will be turning a lot of people away. If you can only write one loan the first year, 2 the second and maybe 4 the 3rd year, you will be turning a lot of people down and they will be instead building relationships with other more stable HMLs. Again, the group I work with is considered somewhat small and we have access to $120 million that we lend out.

    Final thing I think that is getting missed is your foreclosure/non-preforming rate. Depending on which state you are in it can take 2 months up to 2 years to foreclose all the while you as the mortgagee will be responsible for the back taxes when you take the property over. We very very rarely turn a profit when we have to foreclose on a property.

    Suggestions: Offer a lower rate than HMLs in your area, like 10%. Charge 1 point or less (you hadn't calculated points), and make sure the closing fees you use will cover your legal expenses for each loan. Based on returns that I see I would suggest using somewhere around 8 - 9.5% as an expected annual return given the interest and point I suggested.

    Hope this helped shed a bit of light on things.

    [email protected]214-420-7324
    3Reply
  • Adam Peacock
    OP
    Rental Property Investor · Member since 2019 · 48 posts · 38 votes
    7y

    @Ryan Blake Thanks for your reply. You've done this before I can tell so forgive my assumptions. I probably should have articulated profit as gross profit given the number of variables like you mentioned that can each be controlled by varying degrees.

    I agree the rate should probably be dropped a bit for the reasons you mentioned and you make valid points about turning away potential lenders. On that point: how do typical HML's start when they have available cash that is not in the upper $100MM+ realm? Are these smaller HML's considered more like a private lender or do they associate with an established organization so they don't turn customers away due to a shortage of funds?

    Thanks again, excellent points.

    //adam

    0Reply
  • Ryan BlakePro Member
    Lender · TX · Member since 2018 · 936 posts · 713 votes
    7y

    @Adam Peacock

    Yes, you would really be considered a private lender because most of the time you will be lending to people that you have personal contact with. Maybe not a close personal relationship but some face to face contact. I think the big thing for you would be to get some close contacts to you to trust you to lend their money as well. Essentially start a fund. If you have 2 - 4 other people that can invest in the fund about $100k each you will have over half a million that will fund around 3 loans at a time. That is a good start. Then you can show a proof of concept. Most HML funds are trying to get 10% returns for their borrowers so charging 12% + for their services. Then you would take the points and fees to cover your day to day cost and salary for managing over the offerings.

    [email protected]214-420-7324
    1Reply
  • Adam Peacock
    OP
    Rental Property Investor · Member since 2019 · 48 posts · 38 votes
    7y

    @Ryan Blake Thanks again. Given your experience and position in the HML industry, would you go down this path again if you had the choice? I guess I'm asking to both gauge the satisfaction meter of current HML's and listening closely to real-world perspectives on whether it is more, comparable or less profitable than the returns realized by those who are successful in the borrowing community who are the ones buying and renting the homes themselves.

    0Reply
  • Lynnette E.
    Rental Property Investor · TN · Member since 2018 · 2k+ posts · 2k+ votes
    7y

    How are you reinvesting 100% when you have to pay taxes on the profit?

    0Reply
  • Adam Peacock
    OP
    Rental Property Investor · Member since 2019 · 48 posts · 38 votes
    7y

    @Lynnette E. I'm not. I'm purposefully not accounting for every possible liability but calculating gross profit (not net profit) based on a somewhat generalized calculation as a means of comparing an HML strategy versus a home investment strategy to help determine which is more (or less) profitable. Taxes is one unaccounted liability for sure, I've also not accounted for occasions where a foreclosure occurs either. Just running some raw/approximate numbers to see if I'm understanding the basics behind going down the HML path. I could however envision adding an annual ballpark number for liabilities and see how that changes things (for better or worse). This is just to understand the investment strategy of an HML versus a more typical home investor buying homes instead of funding.

    0Reply
  • Adam Peacock
    OP
    Rental Property Investor · Member since 2019 · 48 posts · 38 votes
    7y

    @Jeremy Phillips You are catching me in the midst of a discovery process -- well before any necessary paperwork and other logistics are setup to create a solid HML structure. I'd like to keep your info however so I can reach out once everything is in place. I'll send you a connect request. Thanks for asking!

    //adam

    0Reply
  • Michael Bishop
    United States · Member since 2015 · 401 posts · 394 votes
    7y

    @Adam Peacock if you're looking for an easier and more passive approach to investing, and while you're in your discovery process, have you considered syndication as an alternative vehicle. Returns are often greater than 12% (with the right Sponsor / Operator) and it's about as passive as it gets in the real estate world.

    0Reply
  • Kenneth GarrettPro Member
    Investor · Florida Panhandle/Illinois · Member since 2016 · 4k+ posts · 3k+ votes
    7y

    @Adam Peacock

    I would be a private lender in a heartbeat. The way to avoid taxes would be to place your money in a self directed retirement fund. Then the interest is tax free until you pull it out. Of course the funds are in a retirement fund and you would not be able to use those for personal purposes but it is a strategy. If you did there are some penalties. Check out Mat Sorensen's book on the Self Directed IRA Handbook.

    I use private lenders to fund my BRRRR projects and flips. If you need additional info pm me.

    Good Luck.

    0Reply
  • Adam Peacock
    OP
    Rental Property Investor · Member since 2019 · 48 posts · 38 votes
    7y
    Originally posted by @Michael Bishop:

    @Adam Peacock if you're looking for an easier and more passive approach to investing, and while you're in your discovery process, have you considered syndication as an alternative vehicle. Returns are often greater than 12% (with the right Sponsor / Operator) and it's about as passive as it gets in the real estate world.

    You know I've heard of syndication but haven't really known enough to intentionally look into it further. I'll add it to my research to-do list right after I finish all the BP books I bought (which, if you are new to the BP community and haven't done so, is an excellent source of good information for those starting out). Fantastic recommendation, appreciated Michael.

    1Reply
  • Adam Peacock
    OP
    Rental Property Investor · Member since 2019 · 48 posts · 38 votes
    7y
    Originally posted by @Kenneth Garrett:

    @Adam Peacock

    I would be a private lender in a heartbeat. The way to avoid taxes would be to place your money in a self directed retirement fund. Then the interest is tax free until you pull it out. Of course the funds are in a retirement fund and you would not be able to use those for personal purposes but it is a strategy. If you did there are some penalties. Check out Mat Sorensen's book on the Self Directed IRA Handbook.

    I use private lenders to fund my BRRRR projects and flips. If you need additional info pm me.

    Good Luck.

    Good point and sadly I have a sour taste on the use of self-directed IRA's. Interesting story: an acquaintance I met (his wife was my agent when I bought my first property) convinced me last year to put money into a commercial property with 100% return on paper. Problem is, he did not disclose he was being paid to source my money and due to severe mis-management of things, the deal resulted in a 100% loss for everyone who touched it and there was an old woman this acquaintance convinced to invest her life savings to the tune of over $300k. I had limited trust in this person at the time so I only invested $25k as a trial balloon (The first rule in investing is to learn how to manage risk: best way I know to do this is to never invest more than you're willing to lose). Anyway, obviously I lost my principal, learned a lot of lessons and cut ties with this individual but I realized the experience resulted in a sour taste for things that are actually quite harmless otherwise. I need to see how much I can put into a self-direct IRA again since I have one today with a $0 balance. :)

    //adam

    0Reply
  • Kenneth GarrettPro Member
    Investor · Florida Panhandle/Illinois · Member since 2016 · 4k+ posts · 3k+ votes
    7y

    @Adam Peacock 

    I am so sorry to hear about that terrible experience and the woman who lost 300K.  There are definitely sharks out there.  

    One thing for sure, you are investing in the person almost more than the project.  This requires plenty of due diligence on the person as well as the project.  A true track record is necessary to confirm your money is at least as safe as can be.  Many people lost lots of money when the market crashed.  My 401K lost 1/2 of its value and it wasn’t in real estate.  I have done some private lending (self directed retirement funds) as well, for the most part it’s been positive.  So I have experience from both sides; lending and borrowing.  If you go back to lending check the person out.  Make sure and confirm there experience as best you can.

    I always invite my investors to the project so they can see progress and there investment is safe or at least as safe as can be. There is always sone degree of risk in everything we do, we are just trying to minimize it. I send monthly updates as well. Always make sure on smaller projects as in SFH or 4 units and under you are in the first position lien holder to secure your money. I know in our area we had a similar situation. Private Investor put in 225K, the person and the project never progressed. They ended up foreclosing and were able to take possession of the property. They are now going to complete the project with my help. Because he was in the first lien position he was able to protect his investment.

    Good Luck.

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